Who is In Charge Of Asia's Family Businesses?

Many leading companies in East Asia, including Korea, Japan, Taiwan, and China, are family businesses that play a critical role in the rapid development of these economies.  Samsung, like many other leading companies in Korea, is a family-controlled conglomerate. It contributes to over 20% of the country’s GDP – that almost equals total government spending. McKinsey provides a bold projection that, by 2025, an impressive 40% of the world’s large enterprises will be family or founder-controlled businesses from emerging markets.  Studies have shown that family businesses in Asia tend to maintain stronger value, employee loyalty, entrepreneurship, and execution capability. This is mainly because in order to conduct and protect business transactions, private relationships are important in East Asian economies (as they are in other emerging markets).  With the absence of fair and effective rule of law, it is risky to form new businesses with outsiders beyond the family circle. Instead, family businesses take shape with the father as CEO, mother as chief accountant, and children (who often do not even have formal contracts) in charge of key functional areas. This helps them avoid the risk of dealing with outsiders and reduce transaction costs, which contributed to creating the East Asian miracle.

These family businesses are now at a crossroads . As they continue to grow through unrelated diversification and international expansion, they are forced to involve outside investors and face a broader group of stakeholders while they keep a firm grip on control of their companies.  Should, or can, they keep the company family-owned or should they relinquish control?

The traditional relation-based societies in East Asia are also going through the transformation of relying more and more on public rules. As featured in our earlier column (“Governance Paradox in East Asia”), as the scale and scope of the market expand, developing new relationships incurs higher marginal costs. This weakens the cost advantage in global competition against companies from developed countries. The rule-based governance seen in developed markets offers far more efficient governance for large scale transactions since it costs little to enforce additional transactions.

As their economies expand, East Asian countries embark on institutional reforms to establish rule of law for the society and embrace rule-based governance in corporate operations. This implies replacing the traditional family-based governance with the new corporate governance practices that require an effective board with independent directors, information transparency, CEO accountability, and so on.

Despite the advantages of fast decision making and entrepreneurship, there are inherent costs associated with family businesses.  The controlling family keeps control of the company within the family even if some family members, such as founders’ children, lack the necessary competence and interest to carry on the family value. It may also tunnel the company resources into the family at the expense of other shareholders. These problems are most salient when the economy experiences a large-scale turmoil, such as the 1997 East Asian financial crisis. There was wide-spread criticism of family control as the main cause of the economic crisis. Since then, these countries strived to transform the family governance system into rule-based governance.

However, the governance reform can be risky. It often faces resistance from the controlling families of these businesses, hurting their performance and creating a governance vacuum.  How should the controlling families react to such reforms?  Would it lead to higher value creation if they relinquish their control and embrace rule-based corporate governance?

Governance reform in Taiwan in the early 2000s provides a rare historical case from which we may learn valuable lessons. The Company Law was amended to require disclosure of cross-holding information in all listed companies, which was followed with an online system of information disclosure and a series of regulations to improve the quality of information disclosed by the Taiwan Stock Exchange (TSE). TSE also engaged in annual reviews of companies’ information disclosure and released the results online for easy access by investors. Newly listed companies were also required to reserve two seats for independent directors.

Studying these historical events and subsequent results provides a few interesting insights that may offer guidance for China and other East Asian countries. First, the shareholder protection index (which measures the efficiency of corporate governance) improved from 5.4 to 7.2 after the reform, which is also positively correlated with firm performance. Second, we found that the reform led to a higher concentration of family ownership from 28% to 32%. At the same time, the study reveals that these families relinquished control after the reform, reducing their board control from 23% to 15%.  Controlling families reacted positively to the reform by increasing their ownership, but with more distributed control.

In conclusion, the Taiwan case shows that governance reform toward a rule-based system leads to higher firm performance which benefits controlling families financially; this in turn led to the families’ further investment in the companies. The families also seem to conform to the reform, reducing their control in corporate governance. It is wrong to assume that East Asian reform toward rule-based governance would undermine family businesses. In fact governance reform improves corporate performance as shown in Taiwan, Korea, and other emerging economies. Family businesses still maintain their unique advantages of speedy and entrepreneurial growth while they turn to professional management in corporate operations. This then leads to sustained growth of family businesses, which will continue playing critical roles in their economies. In fact, this is what happened in mature and rule-based economies:  when it comes to corporate governance, family businesses are no different from those that have no one with family ties at the helm.



Seung Ho Park is Parkland Chair Professor of Strategy at CEIBS, Shaomin Li is Eminent Scholar and Professor of International Business at Old Dominion University Strome College of Business, and Yung-Chih Lien is Associate Professor at National Taiwan University.